Taking a Closer Look at Vanguard Natural Resources LLC

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In an attempt to get to the facts on some of the oil and gas upstream companies from time to time in the next 10 days we are going to publish our thoughts on some research so we can know where the bargains are (or aren’t) in this sector

We have chosen to look at  Vanguard Natural Resources LLC (ticker:VNR) first.  Part of the reason we chose VNR is because of some very detailed data that is available from the company.  The other reason is that we had identified this as an issue that maybe we wanted to buy in the coming weeks. 

1st off VNR is 70% natural gas, 15% oil and 15% natural gas liquids–thus they are tilted strongly to natural gas.  Thus this makes them of interest to us. The company published on 10/15/2014 a grid which outlines the sensitivity of common unit distribution coverage given varying levels of natural gas and crude oil prices. We have posted the chart below.

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Estimated 2015 Distribution Coverage Sensitivity Matrix

 

     

 

Natural Gas Prices ($/Mcf)

Oil Prices ($/Bbl)           $2.50     $3.00     $3.50     $4.00     $4.50
    $70.00     0.80x     0.88x     0.97x     1.01x     1.07x
    $75.00     0.86x     0.95x     1.03x     1.07x     1.13x
    $80.00     0.88x     0.97x     1.06x     1.09x     1.16x
    $85.00     0.90x     0.99x     1.08x     1.11x     1.17x
    $90.00     0.92x     1.01x     1.10x     1.13x     1.19x
    $95.00     0.97x     1.06x     1.15x     1.18x     1.24x
    $100.00     1.00x     1.09x     1.18x     1.21x     1.27x
                                     

Additionally they published, in easy to understand way, a chart with their hedging activity.  

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      2015E     2016E     2017E
Oil Production Hedged:                  
% Hedged     70%     31%     2%
Weighted Average Floor Price ($/Bbl)     $91.95     $90.60     $86.60
                   
Natural Gas Production Hedged:                  
% Hedged     77%     59%     33%
Weighted Average Floor Price ($/MMBtu)     $4.35     $4.41     $4.26
                   

As one scans over these charts one can see that it is likely that the common unit distributions–12.05% at this moment–are just barely covered at current oil and gas prices.  Not too bad as long as prices remain at current levels (or higher)–and our best guess is they may go some lower in the month ahead (natural gas and oil).

From this information, in a very quick analysis, one can see that the preferreds, VNRAP, VNRBP and VNRCP all are likely relatively safe at current natural gas and oil prices.  The 3 issues are currently yielding between 8.7% and 9.6% so TODAY does the reward compensate for the risk.  Today we have to say NO.  Do we say this believing that there is a high likelihood of a suspension of dividends on the preferreds–no.  We want a higher reward because I can guarantee that if crude oil and natural gas prices fall much from current levels and VNR has to reduce the common unit distributions that the preferred units will take an immediately smackdown.  Once a distribution cut occurs on the common units investors will immediately want to exit all related securities–and a capital loss will occur (at least for some amount of time).

So the bottom line, for us, is that since we believe that natural gas and oil prices will likely go some lower from current levels we do not want to be holding VNR or related securities.  For others, those that believe natural gas and oil have bottomed at current levels, this would look like an attractive entry point.

We do note that VNR points out that they have room to adjust capital spending etc in order to have available cash for distributions, but from our perspective once they start having to play with the financials to make distributions work it is beyond the point of where were want to be with any holding.

Now normally we would pour over a balance sheet to make an investment determination, but given that VNR has laid out some easy to use charts we are not going to spend a bunch of time looking at data that most likely would only cloud the issue.

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